Short-dated Bonds Stay Low After Tepid Auction Response

Shorter-dated U.S. government bond prices were steady at lower levels on Wednesday after relatively weak demand in an auction of $26 billion of 2-year Treasury notes.

Two-year notes were trading 2/32 lower in price for a yield of 2.04 percent from 2.01 percent late Tuesday, while benchmark 10-year notes were 7/32 lower inprice for a yield of 3.89 percent from 3.86 percent.

The auction "was on the downside of average," said Lou Brien, a strategist with DRW Trading Group in Chicago, adding "the bid-to-cover was light ... and the indirect buyers were also light."

Longer-dated Treasurys eased Wednesday as stocks gained on news that regulators had approved lifting investment caps for government-sponsored home finance companies Fannie Mae and Freddie Mac.

The move was seen as freeing up financing for the two biggest U.S. home finance companies and possibly providing a potential buffer for the ailing housing market, and sapped an early safety bid for bonds.

"News that (regulators) will lift the caps for Fannie Mae and Freddie Mac has contributed to the sell-off in the U.S. Treasury market that seemed to have already been reversing in the wake of the equity market recovery," said Marc Chandler, strategist at Brown Brothers Harriman in New York.

Bonds began the day trading higher, after Fannie Mae blamed the grim housing market for a huge quarterly loss, and after data showed a bigger-than-expected drop in new U.S. orders for durable goods in January.

Data also showed that new single-family home sales slumped to a 13-year low in January, lending some early support to bond prices.

Testimony from Federal Reserve Chairman Ben Bernanke had little impact on the market, as he largely reiterated the message that came from Fed Vice Chairman Donald Kohn Tuesday. Kohn, and Bernanke, said the danger that the U.S. economy will weaken further is a bigger worry than higher inflation.

"Their comments are fairly similar," said Mary Ann Hurley, vice president of fixed-income trading at D.A. Davidson & Co in Seattle.

Traders were looking for further market direction from the results of an auction of $26 billion of 2-year notes early Wednesday afternoon.

Investors will be monitoring whether there is much demand for new debt supply at current price levels, given that bonds have been rallying for seven months in safe-haven buying as a global credit crisis has spread to crimp economic growth.

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